On Jamaican Bauxite and the Oil Trading Balance
I spend most of my time these days in the energy markets. But there are still occasions when I return to doing analysis of metals and mining.
Take last week, for example…
While the oil markets were experiencing a bout of volatility, I was enjoying the sun on the island of Jamaica. Some of my time was spent in the town of Ocho Rios on the north coast. The rest brought me inland, evaluating a bauxite mine for possible reworking.
Well, at least my wife Marina got her sunburn in the usual way – on the beach.
I got mine sitting in the back of a Jeep in the Jamaican mountains…
Jamaica just happens to be one of the leading sources of bauxite in the world. And alumina – the major ingredient for aluminum – is extracted from bauxite. That makes this white to reddish mineral a valuable commodity to mine.
But the market for bauxite has been showing some interesting twists that we would do well to pay attention to.
How Higher Prices Transform Trading Patterns
In Jamaica, greater bauxite production is sought, but less of the genuine advantage of that production is remaining in the region.
Despite an ongoing concern over adequate volume in the right locations, the price commanded for the mineral has led to local smelting plants experiencing possible shortages of alumina moving forward.
Higher market prices in some regions over others are transforming the trading patterns… and the prospects for production volume along with them.
Traditional wisdom would hold that putting a production plant near a source of raw material is the most promising way to improve profitability. These days, however, the differentials in market pricing are causing bauxite to move greater distances, along with the volume of aluminum smelted.
In short, what I was witnessing in one market sector last week – metals and mining – prompted some comparisons with a sector much closer to Oil & Energy Investor interests.
That is, of course, crude oil and the price it commands.
A New Dynamic in How Oil Consignments Trade
Prices continue to rise in both London and New York. Yet while the London benchmark Brent remains higher than West Texas Intermediate (WTI), that spread has narrowed to about $12 at open today from more than $18 late last month.
And from the standpoint of the possible changes in the oil trading balance, that narrowing may be a good thing for the U.S. market – at least in the medium term. That’s because a lessening of that spread is likely to keep more effective control of new production at home.
Let me explain.
As we move forward in this new world of oil insecurity, volatility, and geopolitical intangibles, North American unconventional oil production will carry far greater weight.
As I mentioned last week in “Why This Is Not A Peak OilCrisis,” U.S. conventional crude oil fields are declining in production. So are similar fields in Canada.
As prices skyrocket, attention is drawn to the oil sands in Alberta and oil shale basins on both sides of the border. These reserves are more expensive to lift and process, but they are now in the most secure location globally.
However, when that is combined with the difference in price between New York and London, a new dynamic surfaces in how consignments of oil actually trade.
As with bauxite, oil will flow from safe locations to end markets prepared to pay the most for it.
With a spread favoring sale in Europe over the U.S. or Canada, does that mean oil produced in North America will be leaving?
Well, that depends. If the markets remain in a double-digit per barrel range, favoring Europe, traders begin working the spread to maximize return.
Now, this does not necessarily mean crude produced in the U.S. will actually be transported abroad (although that has been known to happen).
For example, for years, BP (NYSE:BP) would produce on Alaska’s Northern Slope and pipe the volume to Prudhoe Bay. However, most of it would never make it to the lower forty-eight. Instead, the oil would then move to Japan (where the price was higher), and BP would replace it with similar-grade crude coming north from Mexican national oil company Pemex.
Given the rapid decline in Pemex production, that is no longer possible. (See “Mexican Oil, Mature Wells, and the Future of Gazprom,” February 28.) What may happen instead is the swapping of contracts, with the actual delivery of oil coming from some place other than North America.
And the problem from all of this?
It Could Stunt the American Economic Recovery
For a country such as the U.S. – which depends upon imports for as much as 70% of its daily oil – the swapping of consignments may not change the production levels.
But it will change what the sourcing of the oil really means.
North American production controlled by foreign contract swaps means the added extraction will not provide enhanced security. In the U.S., we remain dependent on other countries for the bulk of our oil, while more of our own is effectively controlled elsewhere, as well.
Now, global oil trade is dollar-denominated. That means a $116 a barrel price in London and a $104 price in New York is a genuine $12 difference. There are no currency exchange considerations to offset it.
However, the European consumer buys the products produced from crude in euros. A weakening dollar, therefore, provides an additional incentive to move oil production to Europe, where gasoline, diesel, jet fuel, and heating oil can be sold at a premium.
If such swaps take hold, there will be plays for the investor. But it will also mean a potentially worrisome adverse impact to the American economic recovery.
A $12 spread may not be enough to kick-start this in earnest. And it will take time for the swaps to take hold, too.
Yet that was the case with bauxite. That market took years to develop the spread we see coming more quickly now in crude. But the results are nonetheless indicative of what may lie ahead for North American oil production.
You see, I was in Jamaica last week to assess the justification to reopen a mine. My client was Asian-based, and the bauxite contracts would be swapped in Europe.
And that means the bauxite extracted would have no impact on saving a depressed regional metals market.